Are blue-chip punters out of control?

ALMOST a third of all trading on the London stock market is now through high-risk 'bets' placed by speculators gambling with shares they do not even own, Financial Mail has established.

The extraordinary deals - worth billions of pounds a year - are made possible by an explosion in the use of a financial product called Contracts For Difference.

Incredibly, they allow investors to earn dividends and spark a takeover frenzy without buying a single share or paying a penny in stamp duty, and can allow directors to gamble secretly on their own company's share price.

Unsurprisingly, CFDs and their increased use by predatory investors have now attracted the scrutiny of City regulators. In the past couple of years, they have soared in popularity with small investors, pushing the stock market towards a virtual world in which the real drivers of share prices are gamblers who never actually own a stake in anything.

CFDs, which allow investors to bet on the direction of share prices, are proxies for actual shares and are attractive because clients have to pay only a fraction of the cost of the underlying equity - magnifying any gains or losses. When investors buy CFDs, the sellers - mainly large stockbrokers and spread-betting companies - buy the real shares in the stock market.

Though there are no official figures for the amount of share trading due to CFD activity, industry estimates are that it could account for for more than 30% of stock exchange volumes.

Clive Cooke, chief executive of spread-betting firm City Index, said the growth of CFD trading had been fuelled by the volatile stock markets. 'CFDs were only used by institutional investors until a couple of years ago when the first retail products were launched,' said Cooke.

'They caught on because they enable small investors to make money even when share prices are falling. About half our business is now CFDs and we think they account for 30% of trading by volume on the stock market.' His estimate is backed by others in the industry, with some backing the view that up to a third of trades are CFD related.

The Stock Exchange does not monitor trading in CFDs, but volume figures rose sharply last year, up 17% to 37.5m.

CFDs featured in a number of high-profile cases recently, attracting interest from regulators. Last year, fashion entrepreneur Shami Ahmed stalked menswear chain Moss Bros and attempted to boost his bargaining power by taking out CFDs on the shares. Though he owned a 0.3% stake, his CFD interest covered 5.4%. In a then-unprecedented move, broker Cantor Fitzgerald allowed Ahmed to control any vote on the bigger stake.

This month, US investment company Indigo was forced to clarify its holding in offices group Regus. Indigo initially suggested that it held a 15.1% stake and might bid for Regus, but later admitted its real holding was 0.12%, with the rest held in CFDs. Last week, Indigo said it had now secured the right to vote on its CFD shareholding.

The Financial Services Authority has announced plans to include CFDs, spread bets and other ' synthetic' financial products in a new code for directors' dealings.

At present, directors are barred from trading in shares in their own companies when they possess privileged information. This closed period usually applies in the weeks running up to publication of a company's results. CFDs are not specifically included in the code.

The FSA said its latest proposal would clarify rather than change the rules, since trading in CFDs while in possession of privileged information would certainly breach the broad rule on market abuse.

FSA spokeswoman Kate Burns said: 'We can already act against people who do this, but it's important that all our rules are pointing clearly in the same direction. The use of CFDs and spread bets has increased and we felt the code needed to be updated.'

However, just as directors can trade in shares in their own companies as long as they are not in possession of insider information, they can also trade in CFDs.

The obligation on directors to disclose share deals is enshrined in the Companies Act. But the law covers only actual shareholdings, not CFDs or spread bets.

David Buik, a spokesman for Cantor Fitzgerald, defended the existing regulations. 'CFDs are straightforward and transparent,' he said. 'We have a responsibility of confidentiality to our clients, but all share trades are reported to the London Stock Exchange and CFDs are reported to the FSA.'

The ABC of CFD TAKE an imaginary company, British Widgets, where the shares are 100p. Two would-be investors are looking at the company, but each has very different views on how the shares will move.

Larry Long believes British Widgets is an industrial champion whose shares can only go higher - 'going long' in City speak. He buys a long CFD against 10,000 shares in the company. The CFD broker asks for 20% of the value of the contract so Larry pays £2,000 plus a small commission. The contract is worth £10,000 and will rise if the shares go up.

Sam Short is not convinced and believes the shares will fall - 'going short'. He buys a short CFD on 10,000 shares. Sam also pays his initial 20% or £2,000. His contract is also worth £10,000, but it will rise in value if the shares fall. Two days later British Widgets issues a disastrous trading statement. Its finance director has run off with the chairman's secretary and the company has a huge hole in its finances. Shares in British Widgets plunge to 50p.

Sam Short is very happy. The difference in price is 50p a share, or a total of £5,000. That, minus commission and interest charges, is straight profit to Sam and he gets back his £2,000 deposit.

But Larry Long is in serious trouble. The difference between the two prices in his contract is also £5,000 but in favour of the CFD broker. He lost his initial stake of £2,000, and now owes the broker an extra £3,000. He could close his CFD now and pay up, or he could hang on and hope the shares go back up. But if they fall again he will owe even more.